[Edaily Kim Kook Bae Reporter Lee Jeong-yun] Although the consumer price inflation rate has declined for two consecutive months, the Bank of Korea faces a growing dilemma ahead of this month’s benchmark interest rate decision. While overall inflation has slowed due to falling agricultural prices, the sharp rise in core inflation shows no signs of abating. At the same time, there are significant concerns that raising interest rates further would increase the interest burden on indebted households, potentially weighing down domestic demand, which is already recovering slowly.

According to the National Data Agency on the 3rd, the consumer price index (CPI) in October rose 2.8% year-on-year. This marks the second consecutive month of deceleration, following a drop from 3.1% in August to 2.9% in September. Prices for agricultural, livestock, and fishery products fell 0.3% in September and 1.7% in October, pulling down the overall inflation rate.

The issue lies with core inflation, which the Bank of Korea is closely monitoring. Core inflation—excluding food and energy, which are subject to temporary price volatility—remained at 2.8%, the same as in September. Although it had fallen from 3.4% in August to 2.8% in September, it did not decline further in October. It remains above the Bank of Korea’s price stability target of 2%.

One reason core inflation remains high is that the burden of accumulated cost increases is being reflected in consumer prices with a time lag. A prime example is so-called “chipflation,” where soaring semiconductor prices driven by the artificial intelligence (AI) investment boom are pushing up the prices of finished products such as computers. The Bank of Korea assesses that rising prices of raw materials, such as naphtha, are also adding to the pressure. In October, the rate of increase in public service prices rose from 1.5% to 1.7%, while that for dining out rose from 2.5% to 2.9%. Although the rate of increase for personal services overall and durable goods slowed somewhat, they still underpin core inflation at 3.3% and 4.8%, respectively.

Amid these cost pressures, the pace of price increases for goods has recently begun to outpace that of personal services. According to an analysis by Edaily of seasonally adjusted price data from the National Data Agency, the annualized three-month rate of increase for core goods in September was 4.4%, the highest level since January 2023. This was 1.5 percentage points higher than the rate for personal services (2.9%). The sharp rise in semiconductor prices, which has been reflected in the prices of certain consumer goods such as computers, is fueling the upward trend in core goods prices.

Lee Ji-ho, Deputy Governor of the Bank of Korea, stated at a meeting to review the inflation situation that he chaired that day, “Core inflation showed high growth rates in travel and dining services, as well as electronics, influenced by factors such as the pass-through of accumulated cost pressures.”

There are also concerns that if this is compounded by a recovery in demand, the inflationary trend could spread to other categories. In its August “Issue Analysis,” the Bank of Korea noted that during past periods when demand drove inflation, price synchrony across categories tended to strengthen when the core inflation rate exceeded 2.5%. The core inflation rate for October was 2.8%, higher than this threshold. While this does not necessarily mean that inflation has spread broadly just yet, it suggests that if consumer spending picks up amid persistent cost pressures, companies will find it easier to pass on costs, potentially prolonging inflationary concerns.

However, additional interest rate hikes to curb inflation could weigh on domestic demand, which is recovering slowly. While the Korean economy posted “surprise growth” of 1.0% quarter-on-quarter in the third quarter, private consumption actually declined by 0.2%. Although there were temporary factors such as strikes at automakers, analysts say it is difficult to view the recovery in consumption as robust. While growth driven by the semiconductor sector continues, concerns are emerging that the burden of interest rate hikes could fall more heavily on vulnerable borrowers with high levels of debt. In September, the average interest rate on new mortgage loans at banks rose by 0.22 percentage points over the course of a month to 4.88% annually. This is the highest level in 14 years and 5 months, since April 2012.

The fact that the won-dollar exchange rate (monthly average) fell from 1,528 won in June to 1,336 won in October, thereby reducing inflationary pressure stemming from exchange rate fluctuations, is a somewhat favorable condition for the Bank of Korea. This is because the decline in the exchange rate is partially offsetting the rise in international oil prices.

Nevertheless, due to “sticky” core inflation, market observers predict that the BOK will resume rate hikes this month. The BOK raised interest rates in both July and August before holding them steady last month. Kim Myung-sil, an analyst at iM Securities, said, “Even though the overall inflation rate has slowed, it is difficult to conclude that underlying inflationary pressures have weakened as well,” adding, “From the BOK’s perspective, it will be difficult to lower its guard regarding price stability based on these figures alone.” Choi Ji-wook, Managing Director at State Street Markets, predicted, “Given the upward trend in core goods and restaurant prices, core inflation in November is likely to rise slightly further compared to October,” adding, “The BOK is expected to raise the benchmark interest rate by 25 basis points to around 3.25% while revising its consumer price outlook upward.”